Does This Make Sense?

The reason that the question of sense comes up is because when you are eligible to make contributions to your HSA, you can deduct those contributions from ordinary income.  In the case of the tax-free transfer, no deduction is allowed – in fact the income isn’t included at all, so therefore the deduction is lost.

For most folks, the deduction against earned income (above the line; that is, this deduction impacts Adjusted Gross Income and Modified AGI, therefore impacting all sorts of other calculations) is much more valuable than any benefit of a one-time tax-free transfer.

If the IRA is the only source of funds that you have available to make the contribution, you’re probably just as well off to take the distribution, pay the tax, and then take the deduction for the HSA contribution in most cases.  This option is available to you every year, not just once in your life.  If you are under age 59½ you will owe the 10% early withdrawal penalty in addition to the ordinary income tax, of course.

Other Than Most Cases

So when would it make sense to use this one-time tax-free transfer?  I can think of a couple of cases where this might be the right move:

1. If you are under age 59½ and you have no other funds available to make a contribution to your HSA, using the rollover/transfer from your IRA would bypass the 10% early withdrawal penalty.  I would think you’d want to make this your last resort if you’re in that position.
2. If you are in a position where you are eligible to take the distribution from your IRA (you’re over age 59½) but showing the income on your tax return will impact some other external calculation – such as financial aid for college, creditors, state income tax, or an ex-spouse.

Bottom Line

The bottom line of all this is: if you have other current income, use those funds to make your deductible HSA contribution.  If you have no other source of funds beyond your IRA and you are over age 59½, take the distribution from your IRA as taxable income and then make the HSA contribution from there.  As a last resort, if you are under age 59½ and have only your IRA as a source of funds to make a contribution to your HSA – then it might make sense to do the one-time IRA-to-HSA tax-free transfer.

NOTE:  It is important to note that this one-time option does not increase the amount that you can contribute to your HSA, nor does it allow you to make a contribution if you are otherwise ineligible to make such a contribution.

If you can think of other situations where the tax-free rollover from your IRA to your HSA might make sense, please leave a comment below!

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In Part 1 of this two-part article, we introduced the concept of the Health Savings Account.  In this portion, we’ll talk about some more of the specifics with regard to implementation of the plan, including contribution limits, setting up the plan, and taking distributions.

Contribution Limits on the HSA

The amount that you can contribute to a HSA annually depends upon the type of HDHP coverage that you have, as well as your age.  For 2009, if you only have coverage for yourself, you can contribute up to $3,000.  If you have the family coverage, you can contribute up to $5,950.  You must have the HSA in place for the entire year to make the maximum contribution.

If you are at or above age 55 at any time during the tax year, you are eligible to contribute an extra $1,000.  You can make contributions to your HSA for a particular tax year up to April 15 of the following year (no extensions allowed).

For any month that you do not have your HDHP in place, the maximum contribution is reduced by 1/12. In addition to that reduction, the maximum amount that can be contributed to an HSA must be reduced by any:

• amounts contributed to an Archer MSA (including employer contributions; and
• any amounts that your employer contributed to an HSA on your behalf that were excluded from your gross income.

If you have more than one HSA, your total contributions to all HSAs in any given year cannot be more than the annual limit.  If you make contributions to one or more HSAs that are more than the annual limit, the excess will be included in your gross income and could be subject to a 6% excise tax.

The Impact of Marriage (well, one of them)

If either spouse has family coverage, both spouses are treated as having family coverage.  If both spouses have family coverage, you are treated as having family coverage with the lower annual deductible of the two plans.  The contribution limit is split evenly between the two of you by default – but different division amounts can be agreed upon as you see fit.

If both spouses are age 55 or better by the end of the tax year, each spouse can contribute the additional amount to his or her HSA.  For 2009, this would increase your maximum contribution limit for family coverage to $7,950.

Account Setup and Administration

You set up the HSA much the same as an IRA – you choose the financial institution (bank, insurance company, etc.) that you’d like to be your trustee, and simply open the account.

Rollovers can be done into your HSA from another HSA, an Archer MSA, or an IRA.  The IRA rollover is a one-time provision that was started with the passage of the Health Care Act of 2006.  In addition to the IRA rollover, the Health Care Act of 2006 also introduced the one-time rollover from a Flex-Spending Account (through tax year 2011) of one year’s HSA contribution amount, as long as you had at least that amount in your FSA prior to September 21, 2006.  For more information on the tax-free transfer from your IRA, see this article.

Distributions from your HSA

You can take distributions from your HSA to pay for or reimburse yourself for qualified medical expenses.  Qualified medical expenses are generally any medical expense that could otherwise be deducted when itemizing your deductions on your tax return (specified in IRC §213).  These distributions will be tax-free to you.  So, during the year, as you are paying for the expenses that make up the deductible amount for your HDHP, you could either take a withdrawal and pay the expense directly, or pay it yourself and reimburse yourself from the HSA.

Any amounts that you withdraw for other reasons beyond paying for or reimbursing yourself for qualified medical expenses will be subject to ordinary income tax and a 10% penalty (just like an IRA).

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HDHP Limits

First of all, the limits for a HDHP are as shown in the following table (2009 figures):

**It should be noted that the Maximum Annual Deductible plus OOP only includes amounts paid within the defined “network” of providers authorized by the plan.  Any expenses outside that network will not be considered within this Maximum Annual amount.

In addition, some family plans have a separate Individual deductible and Family deductible.  When you meet the amount for the Individual deductible for one family member, you no longer have to meet the higher Family deductible for that year. If either the Family deductible or the Individual deductible are less than the minimums for that tax year, the plan does not qualify as a HDHP.

Colleague Mike Chamberlain had the following points to add:

Do not assume that just because your health plan was a high deductible that you are able to use an HSA.

If your plan had a $2000 deductible but paid for office visits and the deductible did not apply, you cannot have an HSA.

If you have a drug deductible that is not connected to the policy deductible it will not qualify either.

Most plans that do qualify state it in the name of the policy or boldly in the paperwork.

Thanks, Mike! — jb

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Benefits of an HSA

There are quite a few benefits to an HSA:

1. Contributions to an HSA are deductible from income – even if you don’t itemize deductions;
2. If your employer makes contributions to an HSA on your behalf (such as via a cafeteria plan) the contributions can be excluded from your gross income;
3. Your account contributions can remain in the account year-after-year until you use them – there is no annual “use it or lose it” clause;
4. Growth in the account (via interest, dividends, or capital gains) is tax-free;
5. Distributions from the account are tax-free if used for qualified medical expenses; and
6. Your HSA is portable – not tied in any way to your employment with a particular employer.  You take the account with you if you change employers or leave the workforce.

Qualifications for an HSA

In order for you to qualify for an HSA, the following conditions must be met:

1. You have an HDHP;
2. You (and your spouse, if married) cannot have any other health plan beyond the HDHP, with the exception of another plan that is limited to the following coverages:
   1. accidents,
   2. disability,
   3. dental care,
   4. vision care,
   5. long-term care,
   6. benefits related to worker’s compensation laws, tort liabilities, or ownership or use of property,
   7. specific disease or illness, or
   8. a fixed amount per day (or other period) of hospitalization.
3. You are not entitled to Medicare benefits (i.e., beginning with the first month that you are eligible for benefits under Medicare, you can no longer contribute to an HSA.  You are still allowed to take distributions from your existing plan, however.); and
4. You cannot be claimed as a dependent on someone else’s tax return.

Qualified Medical Expenses

Qualified medical expenses are those that qualify for the medical and dental expenses deduction under §213. Examples include amounts paid for doctors’  fees, prescription and non-prescription medicines, and necessary hospital services not paid for by insurance. Qualified medical expenses must be incurred after the HSA has been established.

You cannot deduct qualified medical expenses as an itemized deduction on Schedule A (Form 1040) that are equal to the tax-free amount of the distribution from your HSA.

In Part 2 we’ll cover the contribution limits as well as some of the other special considerations for the HSA.

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Universal vs. mandatory coverage

One of the main goals of health-care reform is to make affordable health coverage available to all Americans. To help provide coverage to individuals and families who can’t afford it, most of the proposals provide assistance in various forms, including new tax credits, an expansion of eligibility for Medicaid, and insurance premium subsidies.

In fact, most of the major proposals currently being discussed actually require individuals to obtain health-care coverage (i.e., “mandatory” coverage). Under these proposals, individuals who refuse to get coverage would pay a financial penalty. Similarly, employers would be required to offer health-care coverage or pay a fine.

The “public option”

One of the most significant areas of debate centers on the so-called “public option.” The term “public option” generally refers to the establishment of a government-run health-care plan that would compete with private insurers and provide coverage to millions of uninsured Americans. There has also been some discussion of establishing health-care cooperatives (nonprofit organizations that would be completely independent of the federal government) as an alternative to a government-run health-care plan.

Paying for reform

The costs associated with most of the health-care reform proposals being discussed are significant. The nonpartisan Congressional Budget Office (CBO) estimates that the legislation currently being considered in the House would cost more than $1 trillion over ten years, with a corresponding increase to the federal deficit over that period of time exceeding $200 billion. To help pay for health-care reform, reductions in Medicare spending are built into the House bill. Other proposals to raise revenue include raising taxes on high-income families, and taxing high-end health plans.

In his address to Congress on September 9, 2009, President Obama proposed a health-care reform plan he estimated would cost $900 billion over ten years, and pledged that he would not sign legislation that increased the deficit. The President described a plan in which savings within the current health-care system paid for most of the cost, with at least a portion of any shortfall paid by charging insurance companies a fee for their most expensive policies.

An evolving landscape

There are, of course, many specific provisions being discussed that we haven’t mentioned here, and not all of them are controversial. For example, any health-care reform legislation is likely to tackle some of the current issues relating to pre-existing conditions. The entire discussion is evolving very quickly, however, with new proposals and ideas coming into play daily. The legislation that emerges will affect all of us in one way or another, so it’s important to stay informed.

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Most of us have had situations with family or friends where we’ve witnessed this firsthand – and since Medicare doesn’t really provide much in the way of long-term care benefits, the individual is left with three possible sources to pay for long-term care:

1. private payments from your savings and other sources
2. long-term care insurance coverage (LTCI)
3. Medicaid

Given the tremendous costs for long-term care, many individuals are faced with the distinct possibility that any savings that they have amassed over their lifetimes (and that they hoped to pass along to their heirs) could be quickly wiped out or drastically reduced with a stint in a skilled-care facility.  Then who will take care of the sheep?

Medicaid

Briefly, Medicaid was originally introduced in 1965 as a “safety net” for healthcare, directed to poverty-stricken people.  Along in the late ’80′s, it became clear that this safety net could be quite beneficial to people of modest means, and so the laws were changed to allow for additional beneficiaries of the program through some simple planning.  Later during the early ’90′s, some of the eligibility requirements were tightened up a bit, but there is still benefits to be had for folks who need them.

Eligibility for Medicaid is based upon the amount of assets available – only about $2,000 is allowed to remain in savings vehicles.  Community (joint) accounts are subject to special rules, and depending upon how your state chooses to administer the program, half of these jointly-held accounts could be used as eligible assets.  Other assets, including primary residences, annuities, and life estates, receive special treatment under Medicaid eligibility rules as well.

Retirement Accounts and Medicaid Eligibility

So how are your IRA, 401(k), and other accounts viewed with regard to Medicaid eligibility?  As a general rule, retirement accounts are included as available assets when considering Medicaid eligibility – even if the individual is under age 59½ and otherwise ineligible for distributions without penalty.  This account must be liquidated before the individual would be eligible for Medicaid coverage.

One way to protect assets from liquidation is if the account is in periodic payment status – such as subject to Required Minimum Distribution (RMD) either due to age 70½ requirement or if the IRA is inherited and subject to RMD.  In some states the account in periodic payment status is considered an income source rather than an asset, and so the circumstances might help to protect the account’s assets from being included as a whole for Medicaid eligibility.

For example, if an individual was in RMD status due to being over age 70½, his account would be considered in payment status.  If the account was worth $200,000, this amount would not be counted against him for Medicaid eligility, but the periodic income stream would be.  If he were age 72, his annual required payment from the account would be roughly $7,812, which would be considered for his income budget, approximately $651 per month.  If this was his only income, that amount would be reduced by $60 for personal needs allowances, and the remainder would be paid to the nursing home – with the balance of the cost of the nursing care paid by Medicaid.

If the individual is married and the other spouse is not subject to long-term care, there are allowances made for monthly minimum maintenance needs as well (this varies by state – see the link below for additional information on a state-by-state basis).

What About a Roth IRA?

So, if you’re thinking ahead you’re wondering how this impacts a Roth IRA… since a Roth IRA is not subject to minimum distribution rules.  Rightly so – the Roth IRA is never in a payment status as long as the original owner is living, and as such, Roth IRA assets are counted toward Medicaid eligibility status.  These assets would have to be spent down before the individual could become eligible for Medicaid.

Bottom line…

So the bottom line is that you need to consider lots of things as you think about Medicaid eligibility.  If you have significant assets available, you could be better off to consider a Long-Term Care Insurance strategy, as otherwise your assets might have to be spent down and quite possibly depleted.  Unfortunately there isn’t a “rule of thumb” to use in determining whether LTCI makes sense – each individual’s situation will be a little different, taking into account medical history, family medical history, asset base, age, etc..  This is the sort of analysis that you should do as you near retirement age in order to consider whether or not LTCI or Medicaid could be a part of your future healthcare plans.

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Recent information from Fidelity suggests that a 65-year-old couple who retired in 2008 can expect lifetime healthcare costs to top $225,000 over their remaining lifetimes.  And that doesn’t include long-term care (nursing home or assisted-living) costs.

Four Things to Consider About Healthcare in Retirement

1. It’s not solely Medicare. If you haven’t checked into it yet, and you thought Medicare would be your only insurance in retirement, you’re in for a surprise:  with the co-payments, “holes” in coverage, and coinsurance payments, it’s almost a requirement that you have a supplemental healthcare policy to help out – and it ain’t cheap.  Industry averages for a couple, aged 65, in good health start around $7,000 per year, and go up from there.
2. Retiring early increases the costs. If you’re planning to retire early (and therefore lose employer-provided health coverage) you’ve got to replace it somehow.  These policies are even more expensive than the Medicare supplement policies discussed above – and much more variable due to the complexities of coverage.  This portion of your early retirement deserves (requires!) quite a bit of planning ahead, as healthcare costs could be a significant portion of your monthly expenses in retirement.
3. It doesn’t help to wait. Are you just starting out to consider your options and are close to retirement?  If so, you’re quite a bit behind the curve – there are several things that could be done in the five to ten years prior to retirement that might help you with the costs.  For example, if you’re a little overweight, or a smoker, rectifying these things five or ten years before retirement can have a significant impact on your costs.
4. Knowledge is helpful. Health insurers use a special report, called a Medical Information Bureau (MIB) report to help determine your eligibility for coverage.  Think of it like a credit report on your health.  You can order your own MIB report, in order to look things over to see if there are any red flags (much the same as reviewing your credit report).  If you have a denial of coverage on your report or any issues that could adversely impact your ability to get coverage, it’s best to know that up front and work with an agent or broker who specializes in your issues.

Although these things may seem like a lot of work, they’re excellent considerations to take into account as you plan for your healthcare in retirement.  And – most financial planners these days, myself included, can help you work through the decision-making process.  It’s not simple, and mistakes can be quite costly.

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